Goldman Sachs: "QE3 Is Now Our Base Case"

Like the rest of us, he noted the long and explicit window for zero interest rate policy -- until mid-2013 -- and the explicit language regarding additional accommodation.

Hatzius says quantitative easing is the most likely option for further action:

If there is additional easing, it would likely take the form of QE. After all, "these tools" mentioned in the statement presumably need to be more powerful--or at least not much less powerful--than the action taken today in order to avoid a sense of anti-climax. This means that they are unlikely to consist of small incremental steps such as a commitment to keep the balance sheet large, a gradual shift of the securities portfolio into longer maturities, or a cut in the interest rate on excess reserves from 25 basis points (bp) to zero. This leaves the stronger options, which include QE as well as even more aggressive forms of easing such as rate caps (a form of QE in which the Fed promises to buy as many securities as needed to hit a longer-term yield target), a price level or nominal GDP target, or interventions in non-government securities markets (for which funding from Congress would be needed). Of these, "conventional" QE is very likely the option with the lowest hurdle, and the first one to be deployed.

QE3 could be called off if the economy or inflation pick up faster than expected, or if "the anti-Fed backlash" grows. In the latter case, Hatzius says Bernanke might institute a series of smaller purchases.

Hatzius also notes the significance of the dissenters:

While these points could pose problems for our call, we disagree strongly with one argument against further QE that we heard frequently today--namely that the three dissents from Presidents Fisher, Kocherlakota, and Plosser indicate "the end of the line" for further Fed easing and difficulty for the chairman to get his way. On the contrary, we view Chairman Bernanke's willingness to live with the dissents as a strong signal that he and the rest of the Fed leadership view the need for renewed easing as more important than the institutional norm of consensus decisionmaking. There is no question that Bernanke will always have enough votes, and we fully expect him to use these votes to provide further support to the economy if he views it necessary.